Unruffled trading despite political twists

Market analysis - 3/9/2018

Markets took a breather despite a busy week for political developments and news that was theoretically adverse

 The Italian election results reflected difficulties in securing a majority government and a surge in support for the two, most anti-European parties.

Donald Trump’s decision to introduce import duties on steel and aluminium triggered hostile reactions abroad but also within the US. Gary Cohn resigned in protest and Paul Ryan was also against the idea despite being in the Senate majority.

Elsewhere, Mario Draghi’s press conference after the ECB meeting tended to reassure investors even if the bank's stance came across as a little less accommodating. Company results continued to surprise on the upside even if economic data seemed to point to Europe stabilising, admittedly at a high level. As a result, we have maintained our upbeat view on equities, especially in Japan and in the eurozone.

  European equities

European equities moved higher. Political uncertainty following the Italian election results was largely shrugged off by markets and Italian equities even outperformed over the week. The ECB raised its growth forecasts for 2018 from 2.3% to 2.4% but said underlying inflation still remained soft; hence its decision to continue with its accommodating monetary policy. The euro and long bond yields reacted by falling and interest-rate sensitive sectors like property, telecoms and utilities, returned to favour.

Engie rose sharply after returning to the black in 2017 and delivering reassuring guidance for 2018. Its promise to raise the dividend this year was also seen as positive.

The group’s 2016-18 transformation plan, which aims to refocus on reduced carbon-footprint activities and more profitable areas, is going well. Thales also jumped after reporting robust 2017 results and providing encouraging guidance for this year. Like-for-like fourth quarter sales rose 14.8% and FCF hit €1.36bn, or much more than expected. 

Dassault Aviation’s 2017 sales came in at €4.8, up from 3.58bn in 2017. Adjusted net profits were €489m, up from 384m. Management confirmed that the jet aircraft market was recovering and said the military segment afforded lots of opportunities in countries like India and Malaysia.

In corporate transformation news, share prices moved in tandem with rumours of future sales of French government stakes. ADP rose on suggestions by a news channel that it would be entirely privatised. A bill to that effect might possibly be introduced next month said the source. Renault also rose when Reuters reported that the government might sell its 15% stake to Nissan, thereby reinforcing Franco-Japanese cooperation. Such a move would also increase the number of shares held by the group itself and might help reduce the share's discount. Renault reacted by denying the rumours. After reporting record profits in 2017, the group is on track to benefit from a recovery in major emerging markets like Brazil and Russia and also from extending its offer in India, Iran and China. Telecom Italia rose after the activist Elliott fund bought a stake. Fourth quarter figures were also better than expected. AXA surprised the market and tumbled on news it was to acquire Bermuda-based XL Group. The deal is bigger than expected and will involve AXA buying XL Group’s reinsurance business (33% of XL’s sales) even though Axa left this sector entirely back in 2006. What's more, the IPO of AXA US is still pending and there will be no share buyback programmes.

  US equities

US markets had a good week with the S&P up 2% and the Nasdaq 3% higher. Non-manufacturing ISM came in at 59.5 or slightly lower than the previous month, but it was still better than expected. Durable goods orders fell 3.6%, or in line with expectations. The market was only briefly affected by news that Gary Cohn, Donald Trump's closest economic advisor, had resigned over the decision to increase customs duties on steel and aluminium. Investors were relieved when Donald Trump’s hardline approach subsequently turned more accommodating and by warmer relations between North and South Korea.

The higher import duties will come into force in the next two weeks and Mexico and Canada will be exempt. Other countries might also be spared. The threat of an out-and-out trade war seems -for the moment- to have waned.

In company news, Cigna (health insurance) unveiled a $67bn cash-and-stock bid for pharmacy benefits manager Express Scripts. This follows the merger between CVS Health and the mutual insurance company Aetna and illustrates the ongoing trend towards vertical consolidation between insurance companies and distributors. The goal is to wield greater clout with pharma companies. However, the market appears to view this latest deal as essentially a defensive move to ward off any incursion from Amazon into the drug distribution market.

  Japanese equities

 Tokyo was in a cautious mood after the US government’s announcement on imposing additional duties on steel and aluminum imports raised concerns over a possible increase in protectionism. However, the TOPIX end the week 0.09% higher as geopolitical risk over North Korea receded. Upside was limited by trade concerns and the yen’s rise to 105 against the US dollar.

By sector, Pharmaceuticals (+2.51%) outperformed the market. Eisai surged 10.18% on news of its alliance with Merck in the US over developing a new anti-cancer drug and Daiichi Sankyo gained 4.48%. Warehousing & Harbor Transportation (+2.30%) and Mining (+1.70%) sectors were also relatively strong.

In contrast, economically sensitive sectors such as Marine Transportation (-3.12%), Nonferrous Metals    (-2.96%), Steel (-3.04%), Machinery (-1.44%) and Transportation Equipment (Autos) sectors were weak. Komatsu tumbled 5.56% and Sumitomo Metal Mining ended the week 5.09% lower.

That said, if US duties are imposed only on steel and aluminum, the effect on Japanese exports will be limited because steel and aluminum exports only accounted for 0.3% and 0.1%, respectively, of total exports to the US in 2017.

In a contrast to protectionist trends, the Japanese-led TPP11 (Trans-Pacific Partnership) agreement was signed by 11 countries, but not the US, to promote free trade and establish appropriate standard trade rules.


  Emerging markets

Emerging markets rebounded by more than 1.5% in US dollars. China’s trade surplus for the first two months of 2018 was $54bn, up from 38bn for the same period of 2017. Exports rose 24.4%. The higher-than-expected surplus is unlikely to ease pressure on already very tense relations between the US and China. China's inflation for February came in at 2.9%, also higher than expected due to rising food prices during the Chinese New Year. New loan growth slowed slightly to 11.2% as financial companies reduced leverage.

This week’s company results were excellent. Wuxi Biologics said 2017 earnings growth should be 75-80% or 12-15% higher than expected. In e-commerce, Baozun saw non-GAAP earnings soar 128%, well above expectations and the company sees sales jumping 57% in value this year. AutoHome’s profits rose 89%, another beat, due to excellent control of administrative spending.

In India, manufacturing ISM fell to 47.8 in February or well below expectations. In Indonesia, earnings at Bank Central Asia rose 18%, or better than pencilled in by analysts.

In Brazil, recurring net profits at Localiza more than doubled (+104% excluding the cost of acquiring Hertz Brasil and a 17-agency franchise) which was higher than estimated by analysts. PagSeguro (online or mobile payment-based e-commerce services for commercial operations) saw net profits soar 275% last year on the back of a 183% YoY surge in transactions. In Mexico, consumption continued to slow in December, rising by an annualised 1% due to falls in real wages and less dynamic consumer credit. Even so, airport traffic remained strong with an 11% increase in passengers in February.

In South Africa, Standard Bank’s earnings rose 14%, or 5% better than expected, and the dividend was increased by 17%. Management is upbeat on prospects for 2018.


Oil prices rose to excessive levels at the beginning of the year but have stabilised in recent weeks at $63-65 for Brent and $60-63 for WTI. Reports from the IEA and EIA are marginally negative for oil prices. Demand expectations have remained unchanged, a good point as it was already robust despite high prices, but both agencies have once again raised expectations of US output. The EIA now sees 1.38 million b/d in 2018.

We, however, view these expectations are particularly optimistic. The IEA sees US production meeting 80% of demand growth by 2023 which leaves little room for the others and suggests OPEC will lose market share. On the contrary, production from Saudi Arabia and its allies in the Gulf could offset the expected sharp drop in Venezuelan output. After producing 2.35 million b/d at end 2015, 2. 1 million end 2016 and 1.7 million end 2017, Venezuela’s output could continue to decline to around 1.1 million b/d by 2023. Media coverage of dramatic conditions in the country has been thin but the fall could be even quicker. In addition, strong Saudi-Russian ties, as evidenced in several cross holdings in projects, should help them extend their production cut agreements.

In metal news, Donald Trump signed the decree introducing 25% import duties on steel and 10% on aluminium. In the end, Canada and Mexico were exempt and other countries could still ask for the same treatment. This is one way of backtracking without losing face over a decision with little support in the country, even among US steel producers. The measure would only have accentuated US inflationary pressure. In the US, 415,000 people are employed in mining and metallurgical industries but there are 16 times more people working in sectors like autos and aerospace which rely on steel and aluminium. 

  Corporate debt



Credit market started the week in thrall to European political risk. The good news came from Germany where 66% of SPD militants voted in favour of the CDU/CSU coalition. The less reassuring news was in Italy where populist parties emerged from the elections with a clear majority. The formation of a new government in Rome will necessarily involve long and complex talks. But the drop on credit markets was relatively mild on Monday morning with no contagion to other markets as investors chose to interpret the election results as a mainly domestic, rather than European, issue. Helped by technical factors, market sub-segments clawed back most of the losses on the same day.

Then, on Thursday, the ECB held a meeting to update its economic forecasts. The governors also delivered a more nuanced message on the likelihood that the bank’s asset buying programme might be extended. The tone was seen as turning slightly hawkish. Over the week, the Main and Xover indices tightened to 52bp and 258bp (-2bp and -10bp).

Total new high yield issuance in Europe was €3.8bn in February, or much lower than the €5.7bn seen in the previous month. New deals slowed due to a revival in credit market volatility and the beginning of the earnings season.

In news on our investment universe, Teva (Ba2/BB) succeeded in raising $4.5bn or 1bn more than initially targeted. Bombardier (B3 neg/B-) is to launch a $500m increase in capital to reinforce its cash position and deal with a seasonal rise in WCR. Eurofins released upbeat figures and Smurfit Kappa (Ba1/BB+) rejected an unsolicited bid from International Paper Company (Baa2/BBB). 


New convertible issues this week included GuideWire Software (software publisher for property and casualty insurance carriers mainly in the US but developing worldwide) with a $300m + 45m greenshoe 7Y issue at 1.25% and with a 30% premium. The proceeds will go on buying a capped call, working capital and other general corporate purposes. Etsy (handmade, vintage and creative goods e-commerce) had an overnight $300m + a $45m greenshoe deal, a 5Y zero coupon convertible with a 37.5% premium to purchase a capped call, repurchase up to $45m in shares and go on general corporate purposes. Deutsche Bank also priced a $300m in 5Y Cash-Settled Equity Linked Notes linked to Voya Financials (a US financial; investment and insurance company) with a 1% coupon and 30% premium.

In the US, optical communication products manufacturer Finisar posted third-quarter revenues that were in-line but a lower gross margin (28.6% versus 30-31% guided by the company). It also guided for lower sales and gross margins than consensus for the fourth quarter, sending the shares down more than 6% post market.

In Japan, the Saga District Court said the verdict regarding the injunction on the restart of reactors 3 and 4 of Kyushu Electric Power Plant in Genkai would be announced on March 20.  


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